Minyanville Mailbag: Mulling Corruption

"That construction worker looks a lot like Todd-0"

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"But now I'm trapped,

Ouuuunnnnnghhhhaaaaah"

-Bruce Springsteen "Trapped"

In keeping with this column's longstanding policy of Over-Sharing, I can tell you that I'd rather not be writing at this exact moment. I had no intention of doing so, as evidenced by my having gotten into my (totally fly) car and motoring all the way to the end of my driveway.

This morning was to be Day 3 of young Superfly's education. Today's topic was "Revenge is to be savored as a fine wine. Swallowed at a calm, steady pace and served at room temperature; balanced between the heat of anger and the coolness of time."

My plans were scuttled by the repaving of the street outside Jeffmacke Global HQ. I am trapped in a haze of tar and diesel until "later", as estimated by my hard-hatted captors.

On the upside, I see an opportunity for a Real Life Case Study, applying today's lessons as sort of a Father Son project.

Let's take a couple educational-themed e-mails, if only to keep the teaching momentum rolling...

Macke-

Regarding Electronic Arts (ERTS), I see that institutions are holding 96.6% of the shares. Is it true that if the institutions "coordinate" (with or without stated agreement) to not sell any shares and only buy more on bad news, this stock will never go down (significantly)?

Minyan Francis

In theory, perhaps. In reality, no.

I'm not John Nash but I think I can walk through the challenges in pulling off exactly this type of stock manipulation. It's actually just a variant on the Prisoner's Dilemma.

Leaving ERTS out of it (they have enough problems), let's just consider an imaginary company with shares 100% owned by institutions. We'll call our company "Meehan Bodily Odor Parfume" (MBOP), a producer of colognes said to "smell like Billy Meehan's shoes".

Pretend you are a fund manager long MBOP, both as part of an little side-deal and because you really like the sales estimates for the new "Man Musk" line.

Now... the institutions owning MBOP number in the 1,000's. They don't know one another. Indeed, not having any connection would be a requirement of our plan, assuming our crooks aren't that dumb. They just know that MBOP has a great track record, as a stock. "No one ever got fired for owning MBOP" they chortle to one another, as something of a code for "dude, I'll prop this thing like Taser (TASR) and buy it, no matter what they say, if you will..."

So far we haven't really diverted from what's called "momentum" for stocks like the homebuilders. But the homebuilders haven't really missed; which is the problem on the short side.

Our hypothetical MBOP isn't quite that well managed. Say they report their 4th quarter and come in a little light on revenues. Just to make our example clear, let's pretend MBOP's Man Musk reported sales of 0 ("zero") vs. estimates of $500mm. "We misjudged the size of the market opportunity for fragrances reeking of Mr. Meehan's footwear" they explain on the call.

At this point we need our hypothetical Circle of Corruption to really kick in and start buying MBOP shares, to keep it from falling "significantly". If you've stuck with your role of "Fund Manager" in our example, you can already see the problem:

I don't even know these guys I'm supposed to be holding hands with. MBOP is a trainwreck. I could buy here, as per my unstated contractual obligation with people I don't know (with whom I am in professional competition). Assuming only a few of the other criminals welch on their buying, I might only lose a couple/ few points on MBOP today.

Or I can bail out of my position, using the buying volume created by my "chum(p)s" to get out totally unscathed...

You couldn't get institutions to "take one for the team" against their financial interests (adding considerable risk, even if the gambit keeps the stock from cratering) if you had signed contracts from them, promising to do so. It's a non-starter to be able to pull off implied collusion. I mean, if 28 baseball owners can't silently agree not to pay a .250 hitting shortstop $8 million per year how would you ever get thousands of institutions, dealing with one another anonymously, to add to a position they can no longer justify (and which, with our hypothetical bad news, has a very real risk of getting them fired for owning it)?

Stocks get propped up, jammed, squeezed and moved in any number of questionable ways, pretty much every day. Just not using that method; though perhaps I'm not being cynical enough.

With that I'm off to brave the fumes and attempt to get to my boy's lesson. Wish me luck and have a great afternoon, Minyans!

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